Indemnity Principle

Business, Legal & Accounting Glossary

Definition: Indemnity Principle


Indemnity Principle

Quick Summary of Indemnity Principle


The principle that the purpose of litigation for the Claimant is to achieve compensation, not to make a profit at the expense of the defendant. The claimant should recover what is necessary to effect restitution and not a penny more. For centuries it has been held that this principle is violated by Contingency fee arrangements, but the restrictions on such arrangements have been relaxed somewhat in the last decade.




Full Definition of Indemnity Principle


In order to indemnify someone, you must first “make them whole.” The principle of indemnity is one of the essential principles of insurance since it is the element of an insurance contract that secures the insured’s entitlement to reimbursement while also limiting how much they can get.

According to the principle of indemnification, an insurance policy must not compensate the policyholder for more than their economic loss. This restricts the benefit to an amount sufficient to return the policyholder to their pre-loss financial situation.

In other words, the indemnity concept assures that the insured is compensated for their loss but does not benefit, gain, or profit from an accident or claim. You will not be paid less than what is required to put you back in the same financial situation.

For example, if you suffer a loss to your home due to a fire and it is estimated that it will cost $50,000 to restore the damage, you would receive $50,000 from the insurance company, subject to the limits of insurance chosen and other terms and conditions of the insurance policy.

However, if you are underinsured, as in you did not obtain a high enough amount of insurance to allow you to be totally “made whole,” this principle still applies because you are not benefitting from your insurance coverage.

Because the value of a human life cannot be measured in monetary terms, the principle of indemnification only applies to property and casualty insurance plans and not life insurance.

Indemnity is a fundamental, regulated principle in insurance that applies to the majority of policies, with the exception of personal accident, life, and other comparable products. This is an exception since it is hard to quantify a human life adequately in monetary terms.

According to the indemnity principle, the insured would get enough money to be “made whole” or to restore them to their pre-loss financial status. In other words, they would be compensated on the basis of the actual loss experienced, subject to the insured’s chosen insurance limits and other policy terms and conditions.

This fundamental precept ensures that the policyholder receives benefits according to their actual losses and does not profit from them. As a result, it is inextricably tied to another basic insurance principle, that of insurable interest, because the policyholder cannot receive an amount more than their insurable interest.

Here are some straightforward examples to demonstrate this principle:

If an insured obtained a $50,000 liability policy for his car and was involved in a crash. The mechanic estimates that it will cost $10,000 to fix the damage and restore the automobile to its original state if it is taken to a licenced body shop. In that instance, the insured would be entitled to receive $10,000 in compensation (or “indemnity”) from the insurer, as that is the minimum amount required to restore them to their pre-loss financial position. Neither more nor less. Simply because they acquired $50,000 in insurance does not ensure they will always receive $50,000 in compensation. The insurance provider will compensate you for the real amount of loss you have experienced.

There are caveats, as the indemnity principle may be superseded by other terms and conditions. If the insured purchased a $10,000 limit on his car and was involved in a collision that was estimated to cost $15,000 to repair, the insured would be entitled to only $10,000 in indemnity from the insurer, despite the fact that the indemnity principle is supposed to guarantee them $15,000 in indemnity (the amount required to make him whole). This is because the indemnity concept is secondary to the amount of insurance acquired and other stipulations such as coinsurance penalties.

This principle exists to protect insurance firms by removing moral hazard. If insureds cannot profit from a claim, they will be less tempted to perpetrate insurance fraud.


Related Phrases


Indemnity
Insurable Interest
Subrogation Principle
Good Faith
Proximate Cause
Indemnity Agreement


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Definition Sources


Definitions for Indemnity Principle are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 20th January, 2022 | 0 Views.